Warren buffet is undoubtedly one of the most successful investors in the world. He has an estimated net worth of $44 billion, he is one of the wealthiest men alive. His fortunes grew from investments made through Berkshire Hathaway, which started as a cotton manufacturer in 1889. Berkshire Cotton Manufactures went into a business merger with Hathaway Manufacturing in 1955. This union was faced by grave technological challenges, which threatened its profitability. Warren Buffet saw an opportunity and bought into the company. He secured its profitability by diversifying into other industries such as Insurance and slowly exiting the textile industry (Bruner, Eades, and Schill 5).
Warren Buffet’s ability to make sound investment decisions is impressive. An attempt to understand his thought process using financial theory would be too complex. This is because financial theory is steeped in models, mathematics, and intellectual idealism. These theories may not be realistically applicable in all investment decisions majorly because of their complexity. To counter this, Mr. Buffet recommends that a good investor should be rational above any other additional technical competencies ((Bruner, Eades, and Schill 6). This is because he believes that logic surpasses instinct, popular opinion especially from media sources. In my opinion, this characteristic is what sets Warren Buffet apart from the rest of the crop. This is because all his investment decisions are based on logic and not financial jargon or even instinct.
The first principal expounds on the importance of rationality by advising against placing importance on accounting reality as opposed to economic reality. Generally, accepted accounting procedures may not recognize a good brand name or the technical competence of a company’s employees. These factors are vital to the success of a business. By examining the economic reality of a company, one can identify such hidden assets and evaluate their value to the overall profitability of the organization. This is in tandem with most of the financial theories, which rely on meticulously collected data and complex analyses to establish trends, which can be used to support a decision.
A smart investor should not waste valuable business opportunities in doubt and slow decision-making. Mr. Buffet and his partner Charlie often make their decisions within minutes. Adequate information is necessary in order to make timely decisions. All the facts regarding the investment opportunity should be gathered beforehand. Once these facts are satisfactory to the investor, he should move and make as soon as an opportunity arises. Failure to act quickly could be a missed opportunity. Buffet also advises that a chance to invest in a desirable company should not be wasted whether it is big such as a take an acquisition or small such as an Initial public offer ((Bruner, Eades, and Schill 5). This agrees with financial wisdom because delays in decision-making will result in lost opportunities. An investor should always be prepared to make an investment decision by gathering information on viable companies beforehand.
Time is money. This is a business quote that rings true across the board. Warren Buffet that the cheapest investment if often the best since most book values for intrinsic value are inaccurate. The shares with the lowest calculation of discounted flow of cash should be chosen as the most viable ((Bruner, Eades, and Schill 7). In business, there is both success and failure. One should be able to recognize a bad business decision quickly and buy out before suffering heavy losses. This saves on both time and money that could be wasted in trying to salvage a bad venture. There will always be another opportunity in the future to make better decisions and more profit.
The ideal investment is one whose intrinsic value increases over time. To achieve this, the company should demonstrate its ability to utilize its capital efficiently to earn returns over and above the cost of the capital investment (Bruner, Eades, and Schill 9). This is the mark of a potentially great investment. To establish this, the financial records of the company should be analyzed to ensure that its intrinsic value is continually increasing. Care should be taken to identify a company, which could be on the decline phase of its lifecycle, and the share value is diminishing. Financial books may show that such a company is good for investment, but in reality, it is waning and will eventually lose its profitability.
As an investor, Warren Buffet changed the approach to calculating the risk and discount rates on investments. It is generally accepted that highest risks held the highest returns (Bruner, Eades, and Schill 9). Accepted models of calculating risks such as (CAPM) or the capital asset pricing model employed an additional risk premium relatively safe investment options such as treasury bonds. Warren changed this thinking by using secure long-term investments to discount the cash flows in his investment portfolio. Consequently, he managed his risks by managing uncertainty ((Bruner, Eades, and Schill 9). He almost entirely undertook debt free investments largely due to his vast resources. Many investors do not possess this kind of financial strength. Getting into debt is often the only option they have to get finances. The decision to go into debt for an investment should be made carefully to avoid loss of the money. Preparation and logic should be used to make the decision on the best company to invest in.
Ignorance is one quality that Warren Buffet detested. He preferred investing in businesses he understood. If the technical aspects of a company were too tough to understand, he did not invest. The same ignorance drives many investors to diversify their portfolios in the name of spreading risks. This is recommended for investors who intend to avoid risks inherent in certain investments (Bruner, Eades, and Schill10). Warren recommends specific investments, which an individual is well acquainted with. It may be desirable to have some basic understanding of the business one intends to invest in but it is not necessary. The management and a staff of the company in your portfolio can take care of the technical aspects of the business.
All investment decisions should be based on solid information and data analyses. Gut feelings and instincts have no part to play in the ultimate decision-making. On this score, Warren agrees with the basis of most financial theories. An investor also needs to possess the prerequisite investment knowledge. Ignorance of the market itself is a bigger cause of failure than actual market performance. All potential investors should educate themselves on the stock market and its trends before embarking on large investments (Bruner, Eades, and Schill 10)
Finally, Warren Buffet believed that shareholders and company directors alike should have an equitable portion of the company’s profits. He did not approve of company executives taking the lion’s share of profits while the shareholders earned peanuts. The long-term consequences of disregarding shareholders were loss of profitability and eventual collapse. Warren believed that by being a businessperson he made a good investor and that by being an investor he also became an excellent businessperson (Bruner, Eades, and Schill11). This equitable distribution of profits is a key ingredient of a sustainable business relationship and a sound financial principle.
Warren Buffet has built an empire from the stock market. His tactics may not agree with accepted theories on finance but they have proven effective. The most vital lessons learnt are that in business, there is no room for guesswork. One has to prepare adequately in order to benefit from arising business opportunities. Knowledge is power and time now and in the future. When the profits finally come, invest in the business, and reward all stakeholders equitably.
Bruner, Robert, Eades, Kenneth and Schill, Michael. Case Studies in Finance:
Managing for Corporate Value Creation. Irwin Professional Publications. 2009